The Analysis Of Oil Price Shock In Nigeria (1970-2014)

Project and Seminar Material for Economics

The Analysis Of Oil Price Shock In Nigeria (1970-2014)


Abstract


An increase or decrease in crude oil price can both be pain and gain to the Nigerian’s economy simultaneously, this is because a strong link between the country’s budgetary operations and the happenings in the international oil market exists. Therefore, this research employed the restricted vector auto regression (VAR) technique, to empirically investigate into the impact of oil price shock on Nigeria’s economy from 1981 to 2014. Both the Augmented Dickey Fuller and Philip Perron unit root test, revealed that all the variables considered in the study are non-stationary at levels, but achieved stationary after estimating their first difference. Furthermore, majority of the variables were found to have long run relationships, justifying the need to estimate the model through the vector error correction model. The short run coefficient deduced from the VECM revealed that oil price shock price shock significantly impacts economic growth in the short run. Also, both the impulse response function and variance decomposition results confirmed the Dutch disease syndrome associated with Nigeria economy, real GDP negatively responded to oil price shock in all the periods despite the positive response of real government expenditure to oil shock in most period. This implies that economic growth is negatively affected in the long run, even though its impact on the real government expenditure seems to be positive mostly, the Pass-through effect it has on high inflation rate, declining exchange rate explains its negative effect on real GDP. In conclusion this study recommends that, for long run macroeconomic growth and performance there is a strong need for policy makers to concentrate on policy that will stabilize and strengthen the macroeconomic structure of the country with specific focus on; alternative sources of government revenue, aggressive savings from revenue proceeds in periods of oil booms, so as to withstand variations of oil shocks in future.


Chapter One


Introduction

1.1 Background of the Study

Nigeria gained an extra US$390 billion in oil-related fiscal revenue over the period 1971 – 2005 (Budina and Wijnbergen, 2008). What has the nation got to show for this? Despite such windfall, Nigeria has an increasing proportion of impoverished population and experienced continued stagnation of the economy (Okonjo-Iweala and Osafo-Kwaako, 2007). The country, like many other oil-rich countries (ORCs) economically underperforms many resource poor countries (Karl, 2004). Her oil wealth has not been tapped to launch her onto economic heights; rather, she suffers from what Robinson, Torvik and Verdier (2006) describe as a resource curse a paradox of poverty amidst plenty resources. Why? One popularly identified bane of the country’s economic situation is the Dutch Disease Syndrome (DDS) the structural economic imbalance resulting from poor management of oil revenue, and perhaps its shocks. Windfalls that result from volatile oil price surges/shocks overwhelmingly flow through the economy; expand the oil sector and penalize the non-oil sector (Mieiro and Ramos, 2010). The resulting decline in the non-oil sector reinforces sharp decline in the economic growth rate when the price of crude oil falls. Budina, Pang and Wijnbergen (2007), however, point out that DDS alone does not explain the slow growth of the Nigerian economy, especially her non-oil sector; rather, they identify volatility (or shocks) of oil price and its effect on other macroeconomic variables as the bane.

Prior to the discovery of crude oil in commercial quantity in 1956 (Adedipe, 2004; Odularu, 2007), the Nigerian economy, though largelyagrarian (Canagarajah and Thomas, 2001), was stable and steadily growing. The pleasant situation continued into the 1960s when agriculture played a dominant role in her economy in terms of contribution to GDP and foreign exchange earnings (Kwanashie, Ajilima and Garba, 1998). The stability and gradual growth of the economy reversed in the era of oil-dominant economy. The reversed situation was synonymous with decline in the roles played by agriculture. The sector shrank in GDP contribution from 66% in 1958/59 (Kwanashie, Ajilima and Garba, 1998) to 16% in 2004 (United State Agency for International Development, 2006). Its contribution to the nation’s export revenues and foreign exchange earnings plummeted from 86% in 1955-59 (Aigbokan, 2001) to 1.8% in 1996 (Balogun, 2001).

These worrisome declines have been attributed to growing activities of oil and mining industy in the country (Kwanashie, Ajilima and Garba, 1998). Balogun (2001) attributes this problem to the poor management of public resources and inappropriate incentives, which in turn may not be unconnected with overwhelming inflow of oil revenues in the 1970s. Crude oil has metaphorically been referred to as the ‘black gold’ (Bamisaye and Obiyan, 2006). The resource has redefined the global economy in general and the Nigerian economy in particular. The impact of crude oil on Nigerian economy has been double-edged. It has benefited the country in some ways, and has in many other ways turned out to be a curse (Ogwumike and Ogunleye, 2008).

Crude oil’s contribution to GDP rose from 1.6% in 1960 to 11% in 2001 (Adenikinju, 2006). This contribution consists of proceed from oil export, local sale of crude oil for domestic refining and local sale of natural gas. However, the contribution has been limited due to substantial involvement of foreign investors in the oil sector, and consequent repatriation of the sector’s profits and dividends abroad (Odularu, 2007). Crude oil also contributes over 90% of foreign exchange earnings in Nigeria (Adedipe, 2004; Adenikinju, 2006). Ogwumike and Ogunleye (2008) concur that the sector dominates other sectors in contributing to export revenues. For instance, it was responsible for over 98% of total export from the country in 2005.

Moreover, the sector contributes to provision of employment in the country (Odularu, 2007). The contribution has however not been relatively significant because it has limited linkages with the rest of the economy (Ibrahim, 2007). As a result, the sector employs only 1.3% of the total modern sector employment in Nigeria (Odularu, 2007). The beneficial impacts of oil on Nigerian economy notwithstanding, the country has not significantly developed (Odularu, 2007). This is due to setbacks caused by oil-related activities. As noted earlier, the structure of the economy has been mal-altered with the advent of oil. Other sectors have relatively declined in size and contribution to the economy while the oil sector has grown in size. For instance, the United States Agency for International Development (2006) notes the association between sharp rise in oil production in Nigeria in 2003 and decline in agriculture as a percentage of GDP from 29% in 2003 to 16% in 2004.

In the same vein, contribution of the manufacturing sector as a percent of GDP has been in decline, in contrast to growth in the oil sector (Adedipe, 2004). Have Nigerian economic setbacks been solely and directly caused by oil activities? Reporting Perrings and Asuategi (2000), Ibrahim (2007) points out that there is weak empirical support for negative impact of natural resources on economic growth and development. Thus, it can be inferred that the poor performance the Nigerian economy may not be entirely due to oil activities, but to factors relating to policy management of oil resources in the country.


1.2 Statement of the Problem

This study is prompted by fewness of studies on the impact of energy shocks on economic growth of oil-exporting countries like Nigeria, unlike studies on oil-importing countries (Olomola and Adejumo, 2006). Besides, the study attempts to query into the general conclusions of many recent studies that oil price fluctuations/market disequilibria have no impact on the Nigerian economy (see Ikla et al, 2012; Chuku, Effiong and Sam, 2010; Olomola and Adejumo, 2006, for a survey).

Moreover, the study disagrees with these studies on explanation of the impact of oil price on economy via monetary variables like monetary supply and interest rates, having noted that their premise derive from Bernanke et al (1997), a study that focuses on an oil importing country, USA, rather than oil exporting countries like Nigeria. This study aims to extend the frontier of knowledge by estimating the impact of the oil price shocks on the Nigerian economic growth using aggregate demand framework that theoretically connect analytical variables, rather than just explaining output behaviour by oil price and host of arbitrarily suggested variables as done by earlier studies.


1.3. Research Questions

The research questions generated from the statement of problems are:

  1. Does Oil price shock have a significant impact on Nigeria economy?
  2. Is there a long run relationship between oil price shock and economic growth in
    Economy?
  3. What kind of causal relationship exists among oil price shock and Economic Growth and other macro-economic variables in Nigeria?

1.4. Objective of the Study

The main objective of this research is to analyze oil price shock in Nigeria (1970-2014). Specifically, the study sought to;

  1. Examine the impact of oil price shock on Nigeria’s economic growth.
  2. Determine the long run implication of oil price shock on economic growth.
  3. Examine the causal relationship among oil price shock, economic growth and other macro-economic variables.

1.5. Research Hypothesis

Hypothesis 1
  • H0: There exists no significant impact of oil price shock on economic growth in Nigeria.
  • H1: There exists a significant impact of oil price shock on economic growth in Nigeria.
Hypothesis 2
  • H0: There exists no significant long run relationship between oil price shock and economic growth in Nigeria.
  • H1: There exists a significant long run relationship between oil price shock and economic growth in Nigeria.
Hypothesis 3
  • H0: There exists no causal relationship among oil price shock, economic growth and other macro-economic variables in Nigeria.
  • H1: There exists a causal relationship among oil price shock, economic growth and other macroeconomic variables in Nigeria.

1.6 Significance of the Study

The impact of oil price shock on world economy has been larger (Hamilton, 2003). In the past three decades, the price of oil has been volatile and given the role in the Nigerian economy, the effects of oil price shock have been very significant and dis-stabilizing. Nigeria has been the major oil producer in African continent but the attacks on oil refineries and the kidnapping of foreign engineers by the movement for emancipation of the Niger Delta in the Niger Delta region was reported to be one of the causes of oil price increase from 2006 to 2007. This notwithstanding, in general, Nigeria’s production can be considered to be not enough to affect the international oil price, thus this assumption is appropriate (CBN, 2008).


1.7 Scope of the Study

This study is concerned with oil price shock in Nigeria. The analysis covers the period from 1970 to 2014, within which occurred many oil market equilibrium-disturbing events.


1.8 Limitations of the Study

1. Financial constraint

Insufficient fund tends to impede the efficiency of the researcher in sourcing for the relevant materials, literature or information and in the process of data collection (internet, questionnaire and interview).

2. Time constraint

The researcher will simultaneously engage in this study with other academic work. This consequently will cut down on the time devoted for the research work.


Chapter Five


Summary, Conclusion and Recommendation

5.0. Introduction

This chapter presents in brief summary and conclusion drawn from the entire work. This includes explanation of approaches used in meeting the expectation of this study. Also recommendations for policy implementation and future research, were suggested.


5.1 Summary

In the first chapter, background of the study, problem statement, the research question, objectives of the research, research hypothesis and the significance of the study were all explicitly discussed.

The second chapter detailed the review of various concepts relating to the subject matter, this was followed by review of oil price related theories majorly the symmetric and the asymmetric oil price transmission theories were discussed. Past empirical literatures that were compared with the findings of this research were also discussed in the second chapter.

Chapter three presents the research method and design adopted for this research. Information on data collection, research design, research techniques and model specification were all discussed adequately, furthermore, a comprehensive frame work and components of the Vector Auto regression (VAR) modelling technique used in this research were discussed explicitly.

In the fourth chapter, data analysis and empirical findings were well presented. Estimation of oil price shock was conducted via the GARCH 1,1 model, unit root test for stationary was conducted through the ADF and Phillip Perron test, Cointegration test for long run relationship was examined through the Johansen Cointegration technique, the result for the vector error correction estimate was also displayed, furthermore the Granger causality/Wald test was conducted to know the direction of relationship among the variables, the model diagnostic tests such as test for normality and serial correlation test was conducted to ensure the efficiency of the model, and lastly, the structural analysis was examined via the impulse response and variance decomposition, to know the relative impact response and magnitude of shocks among the among macro-economic variables considered.


5.2. Conclusion

So far, this research has extensively studied issues relating to oil price shock and Nigeria’s Macro-Economic performance. The focus was on the relationship between oil price fluctuations and some selected macroeconomic variables with specific prominence on real GDP which acted as proxy for economic growth.

The GARCH (1,1) model revealed that the short term value of oil price plays very big role in determining the future value of oil price. This implies that oil price has a mean reverting process and its conditional variance is fit for generating volatility data.

All the seven variables considered in the study were non-stationary at levels, but achieved stationary after estimating their first difference, this re-affirms the conclusions in previous research, that most time series data are integrated of order one. Furthermore, majority of the variables were found to have long run relationships, justifying the need to estimate the model through the vector error correction model. In the real GDP equation the ECM coefficient showed that 51 percent rate of errors are corrected in the long run. And it will take approximately 23 period ahead for the real GDP equation to return to a steady state. The short run coefficient deduced from the VECM shows that oil price shock price shock positively correlates with economics growth in the short run. Increased government revenue during the period of positive price volatility and possible influence on money supply might be a possible explanation to this.

In the causality analysis, a one way causation was seen running from oil price shock to both the real Government expenditure and inflation. Furthermore, the real government expenditure, and money supply both granger causes the real GDP, while a bidirectional causation flows between the real government expenditure and inflation. The casualty findings suggest that oil price impacts economic growth indirectly in Nigeria due to its impact on government expenditure and inflation. The causality result is largely consistent with findings from Oriakhi and Iyoha (2013), Adeniyi et al (2013) and akpan (2010).

Both the impulse response function and variance decomposition results confirm the Dutch disease syndrome associated with Nigeria economy. The real GDP negatively responded to oil price shock in all the periods despite the positive response of real government expenditure to oil shock in most period. This implies that economic growth is negatively affected in the long run, even though its impact on the real government expenditure seems to be positive mostly, the Pass-through effect it has on high inflation rate, declining exchange rate explains its negative effect on real GDP. The variance decomposition result further amplify the results from the IRF and confirms the long run declining impact oil price shock has on economic growth in Nigeria.

The diagnostic test conducted, reveals that all variables selected are well fitted and the VAR system model conforms to all the white noise assumptions.


5.3. Recommendation

The empirical discoveries in this research has painted a negative and unstable future for the Nigerian economic growth if oil price shock persist. Therefore, for long run macroeconomic growth and performance there is a strong need for policy makers to concentrate on policy that will improve and strengthen the macroeconomic structure.

Some recommendations made by this study includes:

  1. Diversifying the revenue base from oil to non-oil exports so as to revive the non-oil exports from its weak performance. This will help to extricate gradually government expenditure and budgetary operation from happenings in the international oil market.
  2. Effort should be made to improve and straighten fiscal institutions in order to improve the management of oil revenue, promote accountability and encourage fiscal prudence in the oil sector.
  3. Aggressive savings from revenue proceeds during the periods of oil boom should be encouraged, so as to withstand variations of oil shocks in future.

5.4. Contributions to Knowledge

This research has expanded the frontiers of knowledge in some ways. Some of the major contributions to knowledge are highlighted below.

  1. In terms of scope, the research extended the coverage of the years of studies (from 1981 to 2014). This enabled the study to capture recent happenings in the international oil market.
  2. Methodologically, The VAR frame work will provide an easy guide for researchers who want to undertake similar studies in the future.
  3. The findings of the study has signal an unsustainable and bleak future for Nigeria’s economy, if crude oil is absolutely relied upon, and corroborates with the findings of researchers such as Oriakhi and Iyoha (2013), Adeniyi et al (2013) and akpan (2010).
  4. The recommendation made in this study will serve as a guide for policy makers to mitigate the negativity attached to crude oil.

5.5. Recommendation for Further Studies

Future studies can examine the causal relationship between oil price shock and other microeconomic variables that were not considered in this research, such as interest rate, balance of payment, external debt and foreign reserve. This will expose further the level of oil price impact on macro-economic performance in the external sector.


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